Revised Asset Allocation Flashcards
(40 cards)
What is investment governance?
This is the structure that is expected to ensure that assets are invested to achieve asset owners investment objectives within risk tolerances and constrains
Draw the framework that connects the IPS, capital market expectations, and the SAA
Draw
What are the three levels of investment governance structure?
- Governing investment committee
- Investment Staff
3) Third party resources
What are the 6 common traits that make an investment governance model effective?
- Articulate long and short-term objectives (returns, liabilities, liquidity, etc)
- Allocate decision rights and responsibilities among functional units - who does what? why?
- Specify the process for developing and approving the IPS
- Specify the process for development and approval of SAA - typically the investment committee
- Establish a reporting framework - where are we now relative to goals? What value has been added?
- Periodically audit - independent 3rd party
What are the different elements of the IPS
- Purpose
- Objectives
- Duties
- Guidelines
- Reporting
What are the extended assets and liabilities listed on an economic balance sheet?
- Human capital (PV of earnings)
- PV of pension income
- PV of expected inheritance
- PV of future consumption
What are the investment objectives of asset only, asset-liabilities, and goal based mandates?
Asset based typically MVO on the assets, does not consider liabilities. This goal is to maximize sharpe ratios.
Asset liabilities are typically using mean variance optimization including the correlation and values of liailities. The goal is to fund liabilities, MVO for excess
Goal based involves sub portfolios each with risk, time horizon, and other constraints. The goal is to maximize the probability of success for each goal.
What are the relevant risk measures for asset based, asset-liabilitie based, and goal based strategies?
Asset - variance, downside risk (VaR, Sortino), monte carlo
A-L - risk of shortfall, volatility of cont
Goal based - overall risk of not achieving, overall portfolio risk
What are the three super asset classes?
- Capital assets (source of value)
- Consumable or transformable - commodities
- Store of value - currency, art, gold
What are the three criteria for specifying asset classes?
- homogenous within class
- Mutually exclusive
- Diversifying
- Must be large, global, and widely investable
- Capacity to absorb meaningful part of portfolio
What are the risk factors that can describe equity investing? Fixed Income?
- GDP growth
- Volatility
- Currency
- Value
- Liquidity
- Momentum
- Size
- Inflation
Fixed Income 1. Inflation* 2. Capital structure 3. Volatility* 4. Currency* 5. Real rates 6. Convexity 7. Default risk 8. Duration 9. Liquidity* More overlap means more correlation
What are the steps to selecting an asset allocation?
- Quantify objectives
- Establish risk tolerance
- Determine time horizon
- Determine other constraints
- Determine asset allocation approach
- Specify asset classes and expectations
- Develop range of choices for consideration
- Test
Why are risk factor models more relevant for liability driven mandates?
They have funding goals and hold more fixed income
What is the difference between tactical and dynamic asset allocation?
tactical is short term, dynamic is longer term
What are the strategic considerations for rebalancing strategies?
- Transaction costs for different asset classes
- Risk aversion makes for tighter rebalancing ranges
- Less correlated assets will have tighter ranges
- Do you believe in momentum?
- Illiquidity
- Derivative use
- Taxes - more likely to rebalance on the downside
What is the objective function for MVO?
Max utility U = E(r) - 0.005*lamda*Var Find the asset class with the highest utility Higher lamda will result in more conservative portfolios Lamba = 0 means you are risk neutral Lamba = 4 means moderately risk averse
What is the global minimum variance portfolio?
This is the portfolio that has the highest slope on the efficient frontier
What is the safety first criteria and what does it measure?
SF = E(r) - Lowest Required Return/SD This measures (subject to z scores) the probability of hitting a goal
What are the criticisms of MVO?
- Very sensitive to changes in inputs
- Concentration - could use reverse optimization or constraints
- Investors care about more than mean and variance
- Sources of risks may not actually be diversified (use factor instead)
- Does not concern itself with liabilities
- Single period framework
What is reverse optimization?
This is similar to MVO but instead you solve for returns rather than weights. You would take starting weights, calculate Beta’s, use covariances with each other and find what the market is implying returns of each asset class would be.
What is the black-litterman model?
This is a modified method of reverse optimization. You can specify the differences you see vs the return results generated by the reverse optimization and then use MVO to see how you should adjust weights.
What is resampled MVO?
This is a monte carlo method where you actually simulate the efficient frontier and then average the results
How can we include less liquid assets in the MVO process?
- Optimize one section and reserve the other section for the illiquid asset
- Include but attempt to model returns (factor based)
- Include and use publically traded data to estimate returns (violates asset class exclusivity)
What is the marginal contribution to total risk?
This is the marginal change in risk for a small chance in asset class weighting. This is the Beta (sensitivity of asset class to return in the portfolio) * Portfolio SD desired at that level
